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What Is an Earnest Money Deposit?

Updated: Sep 7, 2023

Prospective new home owners can often become confused by the strange-sounding terms used throughout the process of looking at homes, finding one they love, and wanting to actually buy that house. There are a lot of steps involved from looking to moving in. One of those steps at the decision-making stage is the earnest money deposit.

The Earnest Money Deposit

The earnest money deposit is important because it tells the seller of the house that you are a committed buyer with the money to go ahead with the sale.

Without the earnest money deposit, there would be nothing to stop a prospective buyer from making offers on many homes, which would result in them being taken off the market until the buyer decided which one they liked best - leaving the other sellers in the lurch. These days, most sellers insist on having a deposit of some kind as a part of accepting your offer.

The Earnest Money Will Be Part of Your Down Payment and Closing Costs

Many people worry that this is an additional cost on top of all the other financial obligations involved in buying a home. The truth is that the money will go towards the down payment and/or closing costs when the sale goes through.

What If I Change My Mind?

The only exception to getting all your money applied towards the sale is if it does not go through. If you change your mind, for example, there will usually be a fee involved, with a small percentage of the money forfeited.

On the other hand, if you want to back out of the sale because the house does not pass the inspection and/or there will be too long a wait for the seller to redress the issues, you should not forfeit any money. Sometimes the seller might also discover that for various reasons, they are not allowed to sell the home. This could be because they are in foreclosure, have a tax lien on the house, or are not aware they are in a flood zone and need to follow certain rules and regulations when selling.

How Much Earnest Money Will Be Required?

In general, it will be around 1% to 2% of the agreed-upon price for the home. You should have this money available before making a firm offer. If it is a lively market, they may ask for 3%, but they might also be willing to haggle on the price if they can be assured of a large down payment and quick sale.

What Happens to the Deposit?

Once you have signed the purchase agreement, the money will usually be put in an escrow account by the realtor, or title holder if you are opting for a foreclosed property. Never give the money directly to the seller. You should of course use only a reputable realtor and be clear about how they will hold the money.

Once the sale reaches the final stages, the money will be released from escrow and applied to your down payment for the house.

What to Do to Get Your Money Back

If the deal falls through, a small cancellation fee might be charged, especially if you change your mind.

The rest of the amount in escrow will be handled based on what is stated in the purchase agreement, so make sure there is a clause about this in the agreement.

The agreement should also state certain contingencies. For example, sometimes even pre-approved customers actually get declined for a mortgage in the end. In this case, you should be able to recover 100% of the earnest money deposit. Issues with the seller not being able to sell, or the home inspection, should also be stated in the clause to ensure you get back you full deposit.


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